Section 994 allows a member to bring an action on the grounds that the company is being run in such a way that he or she has suffered unfair prejudice. This is a long established provision which is preserved under CA 2006. Examples of conduct that may be held to be unfairly prejudicial to the interests of members include the granting of excessive remuneration to directors, directors’ dealing with associated persons, or non-payment of dividends.
Note that under s.260 CA 2006 the shareholder sues on behalf of the company in respect of the company’s loss, whereas under s.994 the shareholder sues for himself.
The statutory right
Section 994(1) CA 2006 provides: “A member of a company may apply to the court by petition for an order….on the ground
- that the company’s affairs are being or have been conducted in a manner that is unfairly prejudicial to the interests of members generally or of some part of its members (including at least himself), or
- that an actual or proposed act or omission of the company (including an act or omission on its behalf) is or would be so prejudicial.”
If the shareholder can show that the company’s affairs are being conducted in a manner unfairly prejudicial to his or her interests, or that some act or omission of the company has unfairly prejudiced him or her (in terms of the reasonable bystander (objective) test – see Re Guidezone Limited [2000] 2 BCLC 310), the court will decide what remedy is appropriate in the circumstances.
Unfairly prejudicial conduct
The meaning of unfairly prejudicial conduct has been developed through case law and you should note the following principles:
- Negligent or inept management of a company – will not amount to unfairly prejudicial conduct unless that conduct amounts to serious and/or repeated mismanagement which puts at risk the value of the minority shareholder’s interest;
- Disagreements as to company policy – (such as a change in direction of the business) will not afford grounds for a petition under s.994;
- Claimant’s conduct – although the conduct of the claimant may be relevant in deciding whether the prejudice was unfair, there is no overriding requirement that the claimant come to court with “clean hands” (see Re London School of Electronics Limited [1985] 1 BCC 99394);
- Breaches of the articles of association – see Lord Hoffmann in O’Neill and another v Philips and others [1999] 2 All ER 961 where he said that “a member of a company will not ordinarily be entitled to complain of unfairness unless there has been some breach of the terms on which he agreed that the affairs of the company should be conducted… [However,] there will be cases in which equitable considerations make it unfair for those conducting the affairs to rely upon their strict legal powers”;
- Bad faith – there is no need to show either bad faith or conscious intent for the conduct to be unfair;
- Excessive remuneration – following Maidment v Attwood and Others [2012] EWCA Civ 998, the courts will take a wide view of the prejudice that may be suffered by a minority shareholder. A minority shareholder argued that he had suffered unfair prejudice on the basis that the sole director of the company had paid himself excessive remuneration prior to the company’s insolvency. The judge at first instance dismissed the petition on the grounds that the remuneration had been disclosed in the company’s accounts. The Court of Appeal found that there was no basis for requiring this level of diligence by a minority shareholder, and that the director had breached his duties by fixing his remuneration by reference to his own interests which amounted to unfairly prejudicial conduct under s. 994; and
- Legitimate expectation – in terms of certain small private companies (which are often referred to as quasi-partnerships (see Ebrahimi v Westbourne Galleries Limited [1973] AC 360)) case law has established that shareholders may have a legitimate expectation that they be involved in the management of the company, and the prevention of such involvement may equate to unfairly prejudicial conduct. For example, in the case of Re a Company No 00477 of 1986 [1986] 2 BCC 99171 the court held that the interests of a member who had risked his capital in the business of a small private company may extend to the legitimate expectation that he will continue to be employed as a director, so that his dismissal will be unfairly prejudicial to his interests as a member.
Section 994 petitions are likely to be expensive, time-consuming and complicated to bring. Since the court has discretion to make such order as it thinks fit, such petitions also bring with them a great deal of uncertainty for the petitioner. Generally, a negotiated settlement will therefore be the preferred option.
Court orders
Under s.996(1) CA 2006 the court has the power to grant such order as it thinks fit to provide relief and, subject to this general power, s.996(2) sets out a list of particular types of order that may be made. These include orders regulating the future conduct of the company’s affairs and requiring the company to do or refrain from doing certain acts. The most commonly made order is to provide for the purchase of the petitioner’s shares by the wrongdoer(s) (only rarely does this result in an order entitling the minority shareholder(s) to purchase the shares of the majority shareholder(s), but see for instance Brenfield Squash Racquets Club Ltd, [1996] 2 BCLC 184). The value at which such shares are to be purchased is a fundamental issue and usually a matter which is argued.
In practice, where one side is willing to buy out the shares held by the other and the dispute centres around the valuation of those shares, the court will encourage the parties to settle out of court by means of a binding third-party valuation of the shares. If the petitioner objects to such an out of court settlement, the court will usually require them to give reasons for their objection.
Therefore, if a shareholder wants to avoid the situation where the court makes an order for the purchase of his or her shares, a petition under s.994 may not be a suitable course of action. Similarly, if the majority shareholder is without funds to purchase the shares, an order for the purchase of shares will not be the most sensible order for the minority shareholder to request.
Valuation Principles
The court has a wide discretion in relation to valuation matters and its aim is to set a fair price. The following principles apply to valuations generally, although the court will look at all the circumstances of the case:
- The courts have traditionally been slow to impose a discount on the value of a minority shareholding in a private company, on the basis that the minority shareholder is being forced to sell his/her shares because of the unfairly prejudicial conduct of the majority shareholder. Therefore in many cases the fact that the shareholding is small and does not confer any control over the running of the company will not be taken into account. This is particularly the case where the company has been controlled and operated by all the shareholders playing major roles (a quasi-partnership). However the court may order a discount to be applied if the shareholding is viewed as an investment or the company is operated along more commercial lines. Shareholders should first attempt to use a valuation mechanism set out in the articles (if any) provided that it is fair. However, if there is no fair method then a court valuation will be necessary.
- The court will try to apply, so far as is possible, a similar mechanism to that provided for in the articles (if any).
- As a general rule the valuation date is that on which the court order was made, unless problems at the company mean that since the court proceedings were commenced there has been a decrease in the value of the shares or the business has changed.
- The behaviour of the claimant may be relevant e.g. if he or she previously rejected a reasonable offer.
For an illustration of the difficulty in bringing a successful claim under s.994 you may wish to read the summary of the case of West Coast Capital (LIOS) Limited Petitioner, [2008] CSOH 72, Outer House, Court of Session (23 June 2008) which can be accessed through Practical Law under the title “Unfair prejudice: Dobbies Garden Centre”.